In his year-end press conference, Prime Minister Manmohan Singh made an extraordinary statement. According to him, the Indian economy had performed better in the nine years of the UPA than in the six years of the NDA before it. If this is so, then he must be wondering why the Congress is facing the worst defeat of its existence four months from now. When asked why the Aam Aadmi Party had destroyed the Congress in last December’s Delhi Assembly election, he surmised that it must have been because of the high rate of inflation that the Congress has failed to tame. In this, he was at best only partly correct. An equally, if not more, important cause is the collapse of the economy.
It is true that the economy has grown at 7.9 percent per annum during the past nine years, against 5.8 percent in the previous six. But in 2003-04, the NDA had steered India out of a five-year recession by halving interest rates. GDP was growing at 8 percent, non-agricultural jobs were multiplying by tens of thousands every day, share prices were rising as if on an express elevator, foreign exchange was flowing into the country, and IPOs (share offerings in new companies) were blossoming on the financial pages of newspapers like flowers.
In the sharpest possible contrast, GDP growth is set to fall to 4 percent this year, a level not visited since the 1970s, industrial production has contracted by 0.2 percent in the past seven months after growing by a measly 1.1 percent in the previous year, and 2.8 percent in the year before, and the rupee has depreciated by almost 20 percent in the past eight months.
Fresh investment, after falling by almost 60 percent in 2011-12 and another 20 percent in 2012-13, is now close to zero; the country is on the verge of a foreign exchange crisis; and the share market is in a state of near-hysteria. Worst of all, after increasing by an average of 7.5 million a year between 2004 and 2009, non-agricultural employment has contracted by an estimated five million, and women’s employment in the rural areas by 9.1 million in the past four years. Another 30 million young people, who would have got jobs had the economy continued to grow even at its long-term average of 7.2 percent, have lost their future.
But even this collapse does not explain the depth of the animosity against the Congress. Its most important cause is the belief among industrialists, small factory owners, micro-enterprises, wholesalers and retailers that it happened not despite but because of the government’s policies. From the first months when industrial growth began, unmistakably, to sag, the Reserve Bank of India (RBI), the finance ministry and the prime minister himself, have laid the entire blame for it upon the global recession. No one believes this, for the simple reason that industrial growth revived to 8.2 percent, with a monthly peak of 14 percent, in 2009-10 after sinking to 2.5 percent because of the recession in 2008-09
To put it bluntly, the bulk of the modern sector of the Indian economy considers the policies that the government has followed to be not only wrong but perverse. It has given up hope of any change while Manmohan Singh and the Congress remain in power. That is why the bourgeoisie of the country — large, middle and small — is lining up behind the BJP’s prime ministerial candidate Narendra Modi, while the entire proletariat is queuing up to join Arvind Kejriwal’s Aam Aadmi Party.
What are the policy errors that have brought the Congress to its knees? Four inter-related ones that go all the way back to 2006. The first, both chronologically and in importance, is its misreading of the cause of inflation. This began not in 2010 but as far back as January 2007. PV Narasimha Rao had dealt with a similar double-digit inflation in 1995 by sharply raising interest rates and curbing money supply, because that inflation had been of the classic demand-pull variety that India had been familiar with.
But the inflation of 2006 was India’s first experience of cost-push inflation in an open economy. Prices were being pushed up not by excess demand within a largely closed economy but by the impact of shortages of food and raw materials around the globe on a relatively open economy. China had become a net importer of crude oil, and sent its price skyrocketing. In 2006, it was also reaching the peak of another of its sharp booms and consuming imported raw materials as if there was no tomorrow.
In the US, President George W Bush had announced a new energy policy in February 2006 in which he awarded a hefty subsidy for the use of ethanol as a transport fuel. As a result, by the end of the year, American farmers had diverted 30 percent of the country’s corn crop from cattle feed to ethanol. This began a relentless rise in world food prices that did not reverse itself until the end of 2008. Australia was in its seventh year of drought and had stopped exporting rice.
To cap it all, 2006 saw a poor monsoon. But the RBI continued to treat the resulting rise in prices as a result of ‘overheating’, i.e, as a demand-pull inflation, and tried to curb it by raising interest rates and squeezing bank credit. It did this relentlessly for 20 months from January 2007 until August 2008, but inflation went its own merry way and rose from 5.4 to 10.3 percent.
The RBI should have learned a lesson from its failure, but the global recession intervened, the government went on a spending binge citing the need to administer a ‘fiscal stimulus’, and industrial growth shot up. So, when the next savage bout of cost-push inflation hit us, caused by an out-of-control fiscal stimulus in China, the RBI admitted that there was a cost-push element at work but cited the inflationary potential that had been created by the government’s huge fiscal deficit to apply the same, failed remedy again. And again as in 2007-08, it had no effect whatever on inflation, which, measured by the consumer price index, is now 1.7 percent higher than it was in March 2010 when the second bout of monetary belt-tightening began. But this time it dealt a death blow to industry, which was already tottering under the double impact of the previous credit squeeze and the global recession.
The UPA’s second mistake was a direct consequence of its first. When it raised prime lending rates to 11 and 12 percent in 2007-08, it also allowed Indian companies to raise money freely abroad to keep their investment cost down. This inflow, on top of large portfolio investment inflows, put pressure on the rupee to appreciate at the same time as it created a powerful industrial lobby in Mumbai that would benefit from it. The RBI succumbed and allowed much of the extra foreign exchange to be sold in the market for rupees instead of impounding it and enlarging India’s reserves.
Therefore, the rupee appreciated to Rs 40 to the dollar; exports began to weaken and, when the Chinese investment surge was over, began to contract. The result was the sharp devaluation of the rupee that began in late 2011, bankruptcy of several iconic Indian companies, failure of many of the 200 or so blue-chip companies that had sold convertible debentures in the US and elsewhere in the glory days to redeem them, and the huge loan repayment burden that the country faces this year.
The UPA government’s third mistake was to use the pretext furnished by the global recession to go on an unprecedented, populist spending spree in the name of inclusive development. This not only pushed the fiscal deficit up from an anticipated 2.5 percent in 2008-09 to 6.1 percent of the GDP, but did so in the form of legal entitlements that became impossible to reduce once the need for the stimulus had ended.
The last mistake occurred in September 2012. Faced with a demand from the RBI to cut the fiscal deficit somehow and reduce ‘inflation potential’ as a precondition to lowering interest rates, New Delhi enacted price hike and other measures that would reduce subsidies by up to Rs 1 lakh crore in a full year.
But the RBI reneged on its commitment and, citing a tiny uptick in the Consumer Price Index, postponed a lowering of interest rates for another six months. The effect was predictable: industrial production fell further and finally went into negative territory. And modern India finally lost faith in the Congress.
It may be too late for the Manmohan Singh-led UPA government to save itself, but it still has time to save the country from economic and, very possibly political, chaos. The eruption of the Aam Aadmi Party has sealed the fate not only of the Congress, but quite possibly of the BJP’s ambitions as well. The next Lok Sabha election is, therefore, unlikely to see a smooth transfer of power to a government that commands the confidence of the international community. Should that not happen, foreign money will flee and direct investors will shelve their plans. Indeed, the prospect of instability that the elections have created has already reversed the inflow of foreign capital of the past two months.
An indecisive result and prolonged horse trading could, therefore, bring on the foreign exchange crisis that RBI governor Raghuram Rajan has been trying to avert. But even if it does not, it will make a lowering of interest rates very nearly impossible. India’s stagflation will, therefore, continue into an indefinite future.
Manmohan Singh has one last chance of averting this and restoring some of the Congress’ tarnished image. This requires nothing more than lowering of the interest rate sharply as the NDA did after 2000. The market has been signalling this need for the past three years.
Last week, the merest whisper that the RBI might lower interest rates in its next policy review again sent share prices shooting up. This has happened again and again since July 2011, but the government has refused to see the obvious. Today, it has one last chance to make amends. The current account external deficit has fallen sharply; exports are rising, the exchange rate is stable and foreign exchange reserves have risen. There will not be another chance.